Lessor Accounting

OPERATING LEASE

Problem 1: Operating lease with Rent-free period and Unequal rental payments

Bristle Company leased office premises to Back Company for a five-year term beginning January 1, 2022.
Under the terms of the operating lease, rent for the first year is P100,000 and rent for the years 2
through 5 is P156,250 per annum.

However, as an inducement to enter the lease, Bristle granted Back the first three months of the lease
rent-free.

What amount should Bristle Company report as lease income for 2022? 2023?

Problem 2: Operating lease with Lease Bonus and Refundable Security Deposit

On January 1, 2022, Champion Company leased a building to Banner Company for 3 years. The annual
rental is P450,000. Additionally, Banner Company paid P252,000 as a lease bonus and P125,000 as a
security deposit to be refunded upon expiration of the lease.

1. What amount should be reported as lease income for 2022?

2. Assume the same information except that the lease commences on April 1, 2022, what amount
should be reported as lease income for 2022?

Problem 3: Operating lease with non-refundable security deposit

On January 1, 2022, Alibi Company leased a building to Lebron Company for a ten-year lease term at an
annual rental of P750,000. At inception of the lease, Alibi Company received P3,000,000 covering the
first two years’ rent and a security deposit of P1,500,000.

Under the terms of the lease, the security deposit will not be refunded to Lebron Company upon
expiration of the lease but will be applied to payment of rent for the last two years of the lease.

What amount should be reported as current and noncurrent liability on December 31, 2022 in
connection with the lease?

Problem 4: Comprehensive

On January 1, 2022, Grand Company purchased an equipment for P2,400,000. The equipment had an
estimated useful life of 12 years and residual value of P240,000. Grand Company leased the equipment
to a lessee on May 1, 2022. The lease is effective for 3 years at an annual rental of P425,000.
Additionally, Rapid Company paid P150,000 to Grand Company as a lease bonus.

Grand Company incurred and paid initial direct costs of P75,000 on May 1, 2022. Also, Grand Company
paid executory costs of P40,000 during 2022.

What net amount related to the lease shall be reported in the income statement for 2022?
Theory:
1. This term is defined as a contract of part of a contract that conveys the right to use an asset for
a period of time in exchange for a consideration.
a. Lease
b. Rent
c. Operating lease
d. Finance lease

2. The classification of lease is normally determined

a. At the inception of the lease
b. At the commencement of the lease
c. When the entity deems it necessary
d. At the end of the lease term

3. Which of the following statements are correct about the inception and commencement of the
lease?
I. The inception of the lease is the date of the lease agreement of date of commitment by the
parties to the principal provisions of the lease, whichever is earlier.
II. The commencement of the lease is the date of the lease agreement of date of commitment
by the parties to the principal provisions of the lease, whichever is earlier.
III. The inception of the lease is the date of the lease agreement of date of commitment by the
parties to the principal provisions of the lease, whichever is later.
IV. The commencement of the lease is the date of the lease agreement of date of commitment
by the parties to the principal provisions of the lease, whichever is later.
V. Commencement date of the lease is the date the lessee is entitled to exercise its right to use
the leased asset.
VI. Inception date of the lease is the date the lessee is entitled to exercise its right to use the
leased asset.
VII. Commencement date of the lease is the date of initial recognition of the lease.
VIII. Inception date of the lease is the date of initial recognition of the lease.

a. I, V, and VII only.

b. II, VI, and VIII only.
c. III, V, and VII only.
d. II, III, IV, VI, and VIII only.

4. Which of the following accounting concepts is used as a basis to determine the appropriate
classification of leases on the part of the lessor?
a. Accrual basis
b. Conservatism
c. Form over substances
d. Substance over form

5. IFRS 16 states that lease payments under an operating lease shall be recognized as lease income
by the lessor on
a. Cash basis
 b. Accrual basis
c. Straight line basis over lease term
d. Straight line basis over the economic life of the leased asset.

6. An entity enters into an operating lease arrangement with a lessee. The lessor receives a lease
bonus from the lessee. How should the lessor account for the lease bonus received?
a. The lessor should recognize the lease bonus as income when received.
b. The lessor should recognize the lease bonus as income at the end of the lease term
c. The lessor should recognize the lease bonus as income on a straight-line basis over the lease
term
d. The lessor should treat the lease bonus as security deposit to be refunded at the end of the
lease term.

7. Initial direct costs incurred by the lessor in an operating lease should be

a. Expensed immediately.
b. Capitalized as part of the cost of leased asset and amortized over the lease term.
c. Capitalized as part of the cost of leased asset and amortized over its useful life.
d. Ignored.

FINANCE LEASE

Problem 1: Direct financing lease

Precise Company is engaged in the leasing business. As a lessor, Precise expects a 12% return. At the end
of the lease term, the leased asset will revert to Precise Company.

On January 1, 2022, an equipment is leased to another entity under a direct financing lease.

The following are the terms of the lease:

Cost of equipment 4,400,000
Residual value-unguaranteed 320,000
Annual rental payable in advance 767,600
Useful life and lease term 8 years
Interest rate implicit in the lease 12%
First lease payment 01/01/2022

1. How much is the gross investment in the lease?

2. What is the unearned interest income on January 1, 2022?
3. How much is the interest income for 2022? 2023?
4. What amount should be reported as lease receivable on December 31, 2023?

Problem 2: Direct financing lease

On January 1, 2022, a lessor leased a machinery to another entity with the following details:

Cost of machinery 3,583,700

Annual rental payable at the end of each year 1,000,000
Residual value 800,000
 Lease term and useful life of the machinery 4 years
Implicit rate in the lease
Before initial direct costs 12%
After initial direct costs 10%
Initial direct costs (1/1/2022) 132,600
The machinery will revert back to the lessor when the lease expires.

1. What is the gross investment in the lease on January 1, 2022?

2. What is the net investment in the lease on January 1, 2022?
3. What is the unearned interest income on January 1, 2022?
4. What is the interest income for 2022?
5. What is the carrying value of the net investment in the lease on December 31, 2022?
6. What is the current portion of the net investment in the lease on December 31, 2022?
7. What is the non-current portion of the net investment in the lease on December 31, 2022?
8. Assuming the residual value is unguaranteed and the fair value of the machinery on December
31, 2025 is P800,000, prepare the journal entry of the lessor on this date.
9. Assuming the residual value is unguaranteed and the fair value of the machinery on December
31, 2025 is P600,000, prepare the journal entry of the lessor on this date.
10. Assuming the residual value is guaranteed and the fair value of the machinery on December 31,
2025 is P600,000, prepare the journal entry of the lessor on this date.

Problem 3: Computation of gross investment; with & without transfer of ownership

On January 1, 2022, a lessor leased a machinery to another entity with the following details:
Cost of machinery P17,248,000
Residual value 2,500,000
Useful life and lease term 5 years
Implicit interest rate in the lease 8%
The annual rental is payable in advance on January 1 of each year starting January 1, 2022?

1. Assuming the lease provides for a transfer of title to the lessee at the end of the lease term,
what is the gross investment in the lease on January 1, 2022?
2. Assuming the machinery will revert to the lessor at the end of the lease term, what is the gross
investment in the lease on January 1, 2022?

Problem 4: With Purchase Option

On January 1, 2022, a lessor leased a machinery to another entity with the following details:
Cost of machinery P10,348,800
Purchase option 1,500,000
Useful life and lease term 5 years
Implicit interest rate in the lease 8%
The annual rental is payable in advance on January 1 of each year starting January 1, 2022. It is
reasonably certain that the lessee will exercise the purchase option at the expiration of the lease term.

1. Assuming the purchase option is actually exercised at the expiration of the lease term, prepare
the journal entry in the books of the lessor.
2. Assuming the purchase option is not exercised at the expiration of the lease term and the fair
value of the machinery on the same date is P1,050,000, prepare the journal entry in the books
of the lessor.

Theory:

1. One of the four criteria for a finance lease specifies that the lease term be at least
a. Equal to the economic life of the underlying asset.
b. 50 percent of the economic life of the asset
c. 75 percent of the economic life of the asset
d. 90 percent of the economic life of the asset.

2. One of the four criteria for a finance lease is that the present value of the lease payments at the
beginning of the lease term must be at least
a. Equal to the fair value of the underlying asset.
b. 50 percent of the fair value of the underlying asset.
c. 75 percent of the fair value of the underlying asset.
d. 90 percent of the fair value of the underlying asset.

3. A lessor shall recognize asset held under a finance lease as a receivable at an amount equal to
the
a. Cost of the leased asset
b. Gross rentals
c. Gross investment in the lease
d. Net investment in the lease

4. All of the following will be included in the lease receivable, except

a. Guaranteed residual value
b. Unguaranteed residual value
c. A purchase option that is reasonably certain to be exercised by the lessee.
d. All of the above items will be included.

5. Net investment in a direct financing lease is equal to the

a. Cost of the asset
b. Cost of the asset plus initial direct cost paid by the lessor
c. Cost of the asset minus guaranteed residual value
d. Cost of the asset plus unguaranteed residual value.

6. In a direct financing lease, unearned interest income

a. Should be amortized over the lease term on a straight-line basis
b. Should be amortized over the lease term using the effective interest method
c. Should be recognized at the expiration of the lease
d. Does not arise

7. Under a direct financing lease, the excess of aggregate rentals over the cost of the underlying
asset should be recognized as income of the lessor
a. In constant amounts over the lease term
b. In increasing amounts over the lease term
 c. In decreasing amounts over the lease term
d. After the cost of the underlying asset has been fully recovered though rentals

8. The interest rate implicit in the lease is the discount rate that causes the aggregate of the
present value of the lease payments and the unguaranteed residual value to be equal to the
a. Cost of the leased asset
b. Fair value of the leased asset
c. Fair value of the leased asset and initial direct costs.
d. Gross investment in the lease.